Investing Assets & Markets Bonds The Basics of Investing in High-Yield Bonds Learn the pros and cons of high-yield bonds By Robin Hartill Updated on October 21, 2022 Reviewed by Khadija Khartit Reviewed by Khadija Khartit Twitter Website Khadija Khartit is a strategy, investment, and funding expert, and an educator of fintech and strategic finance in top universities. She has been an investor, entrepreneur, and advisor for more than 25 years. She is a FINRA Series 7, 63, and 66 license holder. learn about our financial review board Fact checked by Lars Peterson In This Article View All In This Article What Are High-Yield Bonds? How Do High-Yield Bonds Work? What Are the Risks of High-Yield Bonds? How Do I Invest in High-Yield Bonds? Frequently Asked Questions (FAQs) Photo: d3sign / Getty Images Some bonds are known as “high-yield bonds” because they offer higher interest payments to investors. You may hear high-yield bonds described as “junk bonds” or “non-investment grade bonds.” High-yield bonds are risky compared to other bonds, so they compensate investors for the additional risk by offering the prospect of greater returns. Learn the basics of how high-yield bonds work, the pros and cons, and how to invest in them. Key Takeaways High-yield bonds, otherwise known as “junk bonds,” pay higher interest rates to compensate investors for extra risk.Companies that are struggling financially or don’t have a strong track record may need to issue high-yield bonds.High-yield bonds tend to have higher total returns than investment-grade bonds but lower returns than stocks over long periods. What Are High-Yield Bonds? A high-yield bond is a corporate bond issued by a company that’s at a higher risk of defaulting on its debt. Corporations or governments often finance debt by issuing bonds. Basically, when you buy a bond, you become a creditor. Note Rating agencies Moody’s, Standard & Poor’s, and Fitch grade a bond issuer’s default risk. A highly rated bond is considered investment grade, meaning it poses little credit risk. A bond is classified as a junk bond if it’s rated lower than Ba1 by Moody’s or BB+ by Standard & Poor's or Fitch, grades that indicate increased credit risk. Companies may issue high-yield bonds if they’ve had financial troubles or if they’re heavily in debt. A new company may be unable to obtain an investment-grade rating because it doesn't have a proven track record or its business plan is seen as risky. If a company’s financial performance or creditworthiness improves, ratings agencies can upgrade its bonds to investment-grade status. Likewise, investment-grade bonds can be downgraded if the issuing company’s financial health declines. How Do High-Yield Bonds Work? In general, a company works with an investment bank to draft a high-yield bond offering. Once the terms are set, the bonds are offered to investors. Any bonds that are sold before maturity make their way into the secondary market for brokers and dealers to offer to investors. Most corporate bonds offer fixed interest payments called “coupons,” which are often paid semiannually. When a bond reaches its maturity date, the investor should receive the full principal amount they invested (provided the company has the financial means to do so). A high-yield bond is seen as less likely to make on-time payments than its investment-grade counterparts, so it offers higher interest. If the company defaults on its debt and goes into bankruptcy, bondholders are paid only after secured creditors are paid, such as a bank that holds a mortgage. However, bondholders must be paid in full before shareholders recoup any funds. Note High-yield bonds tend to produce higher returns than investment-grade bonds but lower returns than stocks over long periods. In the past 10 years, the S&P U.S. High Yield Corporate Bond Index delivered total annualized returns of 3.64% as of October 2022. Over the same period, the S&P 500 Investment Grade Corporate Bond Index returned just 1.30% as of October 2022. For comparison, the S&P 500 index, one of the most widely followed stock indexes, had 10-year annualized returns of 9.85% as of October 2022. What Are the Risks of High-Yield Bonds? Investors seek high-yield bonds for the possibility of higher returns, especially in times when interest rates are low. But there are several types of risks to be aware of. Default Risk Default risk, also known as “credit risk,” is a concern. Companies that issue high-yield bonds do so because their credit ratings indicate that they’re more likely to fail to default on debt. Investors could lose their entire principal should this occur. Interest-Rate Risk Because interest rates are more likely to change over time, interest-rate risk is greater for bonds with longer maturities. A bond’s value drops as the market’s interest rates rise, and vice versa. So if the market rates rise near the end of your bond’s maturity, its value could go down. Economic Risk In economic downturns, investors often sell riskier assets and seek a safe haven in low-risk investments, like Treasurys. If too many bond traders sell at once, it could push your bond’s price downward. Liquidity Risk Liquidity risk is the chance that you won’t be able to sell the asset quickly for its value. An asset that trades frequently has higher liquidity than one that trades infrequently. High-yield bonds typically have higher liquidity risk than investment-grade bonds. Note Treasury bonds are considered virtually risk-free because they’re backed by the U.S. government. Because the risk is so low, Treasury securities offer extremely low returns. As of October 2022, the yield on a 10-year Treasury note was 1.73%. How Do I Invest in High-Yield Bonds? If you feel the potential returns are worth the risk, you can buy high-yield bonds in several ways. Individual High-Yield Bonds You can invest in individual high-yield bonds by buying them directly from banks, brokers, or dealers. But because the risk of default is high for companies with low credit ratings, buying individual bonds is a risky way to invest, as your money is tied up in a single company. Before investing in individual high-yield bonds, be sure to read the company’s prospectus on the SEC’s EDGAR website to better understand the company’s financial picture. High-Yield Bond Funds Investing in a high-yield bond fund, whether it’s a mutual fund or a high-yield exchange-traded fund (ETF), could be a good way to spread out default risk when you invest in junk bonds. For example, the SPDR Bloomberg Barclays High-Yield Bond ETF (JNK) invests in high-yield bonds with above-average liquidity and maturities between one and 15 years. Its 30-day SEC yield as of October 2022 was 8.98%. The fund’s expense ratio is 0.40%, which means that $40 of every $10,000 you invest goes toward fees. Frequently Asked Questions (FAQs) What are high yield bonds? High-yield bonds are bonds issued by entities that are at greater risk of default than other bond issuers. Since a bond is essentially a loan, bond buyers must evaluate the default risk of the company issuing the debt. The higher the risk, the higher the yield. How do you buy high-yield bonds? You can buy high-yield bonds the same way you buy other bonds and equities. You can purchase bonds issued by individual firms. Or you can purchase bond funds and ETFs, that hold a variety of individual bonds. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. Fidelity. "Bond Ratings." SP Global Indices. "S&P U.S. High-Yield Corporate Bond Index," Click "10 YEAR" above graph. SP Global Indices. "S&P 500 Investment Grade Corporate Bond Index," Click "10 YEAR" above graph. SP Global Indices. "S&P 500," Click "10 YEAR" above graph. Treasury.gov. "Daily Treasury Yield Curve Rates." State Street Global Advisors. "SPDR Bloomberg Barclays High-Yield Bond ETF."